Islamic banking faces liquidity risk: Expert

Doha: Islamic banking sector is increasingly facing liquidity risk across all geographical regions. The situation is more challenging in the GCC region, said an expert.

He called for the industry leaders and the regulators to create new instruments and develop fresh policy tools for  the liquidity risk management in the Islamic industry sector.

Dr Salman Syed Ali of Islamic Research and Training Institute, Saudi Arabia, cautioned that the Islamic banking sector might also go the way of conventional banks, unless effective tools are not in place immediately.

Dr Salman, who was in Doha to attend the International Conference on Islamic Economics and Finance, told The Peninsula: “The structure of liquidity of Islamic banks have changed significantly over the years.  From an era of liquidity surplus in the beginning of the decade Islamic banks are now in the era of liquidity shortages. In general, the banks have moved from a position of positive gap to a negative one or from a negative gap to a more negative one.”

The level of liquidity in Islamic banking has been decreasing while liquidity risk has been increasing in all geographical regions over the past decade. The risk has further increased after the global financial crisis.

Contrary to the general perception, the liquidity of Islamic banking industry in the GCC is lowest with highest liquidity risk when measured by liquidity ratio and financing to deposit ratio.

There has been a major structural change in the maturity profile of assets and liabilities of Islamic banks between the years 2000 and 2009 from a position of positive short-term maturity gap to a negative gap.  This, according to Dr Salman, is a strong indication of a liquidity risk.

In comparison with the conventional banks, the Islamic banks, despite downward trend in their liquidity ratio, are holding much higher proportion of liquid assets.  Even during the financial crisis the liquidity in Islamic banks was more than twice the liquidity of conventional banks. This, among other factors, may have helped Islamic banks to ride out of the crisis.  But things are changing in the industry.

For want of updated Islamic instruments for liquidity management, the fully fledged Islamic banks face more difficulties compared to the conventional banks and the Islamic banking windows of conventional banks. A comprehensive review liquidity management practices and policies of Islamic industry is an urgent need.

“Out of the box thinking is needed to come up with solutions.  Researchers and policy makers need not confine their thinking within the present model of commercial banking and the set-up of the existing financial sector”, he said.

Among the GCC countries, Kuwait had consistently low liquidity ratio over the period. UAE is the country where liquidity ratio dropped most and remained lowest during the global crisis.  Among other countries, Jordan has the highest liquidity ratio consistently since 2004 followed by Malaysia.  The liquidity ratio in Sudan has been consistently showing a downward trend since 2004.

An important measure of liquidity risk is the Financing to Deposit Ratio – a situation that captures the relationship between changing nature of demand for financing and deposit gathering ability of banks to fund that demand.  This ratio is quite high in the GCC and Mena when compared to other regions,  Dr Salman said.

Islamic finance would have prevented credit crunch

The global financial crisis could have been avoided if banks had abided by Islamic rules that forbid investment in collateralised debt obligations and other toxic assets, UK entrepreneur James Caan said.

“One of the questions we always ask is if the global economy operated under Sharia-compliant finance would we have had a credit crisis,” said Caan, the former star of the BBC series ‘Dragon’s Den, during an interview in Dubai. “I think the answer is no actually.”

Sharia-compliant banks fared better than conventional lenders during the downturn, thanks to rules that forbid speculation and insist loans must be backed by collateral.

Banks are also deterred from repackaging debts, as financial instruments generally have to sold for face value.

Caan, who recently purchased an apartment in Dubai’s Burj Khalifa, is touring the Gulf in a bid to drum up interest in a £45m ($69m) student housing product, offered through the Islamic investment firm 90 North, in which he holds a stake.

“When you think today that half the world’s population today is Muslim, as a businessman I see this as one of the biggest growth market opportunities that is under-exploited,” Caan said.

“Potentially over the next five or ten years I can see this as being a very attractive position. I think there is an incredible increase in demand for Sharia-compliant opportunities and products.”

Independent advisory firm 90 North was co-founded by Philip Churchill, formerly of Kuwait-backed Gatehouse Bank. The company has placed nearly £1.1bn ($1.7bn) on behalf of Gulf investors in Islamic-compliant real estate assets to date.

Sharia law forbids gambling, investments in alcohol and receipt of interest, so fund managers have to select investments deemed halal, or permissible.

“Most of the product that we have sourced is UK-based,” Caan said. “The UK is a natural place that I think Middle East investors find very comfortable, because of the governance, the laws and the transparency.”

Islamic banking assets with commercial lenders will reach $1.1trn in 2012, a jump of 33 percent from their 2010 level of $826bn, Ernst & Young said last week.

Islamic banking assets in the Middle East and North Africa (MENA) region increased to $416bn in 2010, representing a five-year annual growth of 20 percent compared to less than 9 percent for conventional banks, the consultancy said.

90 North hopes to tap into the Gulf’s wealthy residents by offering Islamic-compliant property assets with secure long-term returns, Caan said.

“We have identified an investment opportunity in the student housing market. Well respected universities are still getting more applications than they can cater for so the demand side is very high but most universities are not able to meet the demand in terms of accommodation,” he said. “You have predictability of income.”

In ‘Dragons’ Den’, Caan was one of panel of entrepreneurs courted by start-up firms in a bid to secure their investment in return for an equity share.

Caan, who invested $1.5m in 14 companies while on the show, said Dubai remained the leading destination for investment among the six Gulf states.

“If I was being pitched in Dragon’s Den by Abu Dhabi, by Qatar, by Dubai – which one would I back? [Dubai] has the least and has made the most out of it,” he said.

“Look at the region, Dubai probably has the least natural resources so it doesn’t have an option. Its drive and determination is much greater than somewhere like Qatar.”

Islamic finance to gain from global economic turmoil

MANAMA: The global financial crisis has given the Islamic finance industry a great opportunity. The obvious flaws in conventional finance have created great interest in the Islamic financial model, Central Bank of Bahrain (CBB) Governor Rasheed Al Maraj told delegates at the opening session of the 18th World Islamic Banking Conference (WIBC) at the Gulf Hotel yesterday.

“This should provide the basis for the industry to sustain a period of strong growth for the rest of this decade,” he said.

The growth opportunities are especially strong as Islamic finance has its largest presence in rapidly growing economies that have been least affected by the global financial crisis.

“They should continue to register high rates of growth in the years ahead.

“If Islamic finance is to make the most of these opportunities, it still needs to learn from the mistakes of interest-based finance.

“As Islamic financial institutions expand, they need to make sure that their management and control functions keep pace with their growth,” he said.

“As the global financial crisis shows, there is a need for firms, especially those that become internationally active, to make sure that risk management, control systems and information technology are capable of providing an accurate picture of a financial institution’s overall risk profile.

“Boards of directors and senior managers also need to ensure that they have the knowledge, expertise, and professional skills to manage businesses that are growing in complexity,” he said.

“Building high-quality human capital is an essential building block for the expansion of the Islamic finance industry,” he added.

“The regulatory framework needs to keep pace with an expanding industry,” he said.

“The Islamic financial industry is fortunate in that it has several well-established standard setting bodies, including the Islamic Financial Services Board, the International Islamic Financial Market and the Accounting and Auditing Organisation for Islamic Financial Institutions.

“Over the years, these standard-setting bodies have demonstrated their ability to adapt international standards to the needs of the Islamic finance industry,” he added.

“These bodies now need to take the lead in adapting new international standards, including Basel III, to the specific circumstances of Islamic finance.

“Ensuring that firms have strong capital and liquidity buffers should not be seen as an optional extra for the industry, but as an essential foundation for its next stage of growth,” he said.

“The industry will be stronger if it strengthens its foundations, just as the foundations of interest-based finance are now being strengthened,” he added.

Islamic Bonds Make a Comeback

DUBAI — The global market for Islamic bonds, or sukuk, returned to growth last year, shaking off the lingering effects of the global financial crisis, analysts say, with total issuance beating even the pre-crisis year of 2007 and Gulf issuers playing an increasingly important role.

Sukuk issues reached a record $51.2 billion in 2010, an increase from the 2007 peak of 34 percent, according to a report by Standard and Poor’s.

It is too soon to say what effect the turmoil in Bahrain and elsewhere may have on the market, analysts said. But by mid-February, more than $16 billion worth had already been issued worldwide since the start of the year. High-profile issues from the Gulf region included a 3.5 billion dirham, or $953 million, sukuk from Aldar Properties in Abu Dhabi, issued on Feb. 28 and maturing in December 2013.

“What the market has done in 2009-2010 is grow back to the 2007 level of issuances,” said Paul-Henri Pruvost, an analyst covering Central Europe, the Middle East and Africa at S.&P. “Malaysia remains the real driver of the sukuk market, but compared to Southeast Asia, there are other large sukuk markets, such as Saudi Arabia, Qatar and the United Arab Emirates, that have strong economic needs and are still creditworthy.”

After two turbulent years, the market started making a strong comeback at the end of 2010. While Malaysia continues to dominate the sukuk market, accounting for 78 percent, or $39.8 billion, of total issuances in 2010, activity is picking up in the Gulf. The value of Islamic bonds issued in the Gulf alone jumped 61 percent in the past year, with issuances valuing $7 billion in 2009-2010, compared to $4.3 billion the previous year, according to research by the international commercial law firm Trowers & Hamlins. Continue reading

Stability during financial crisis lends momentum to Islamic banks

Islamic banking institutions have weathered the global financial crisis better than their conventional counterparts and are rapidly gaining momentum worldwide, but the sector in Canada continues to face considerable headwinds, a panel of experts said on Monday.

At an Islamic finance conference in Toronto on Monday, speakers commended the impressive performance of Islamic financial institutions and investment products during the financial crisis.

Stability during financial crisis lends momentum to Islamic banks

“Islamic banks have been more resilient,” said Shahzad Siddiqui, a Toronto-based author and lawyer with expertise in Islamic finance.

The speakers partly attributed the resilience of the sector to the fact that Islamic banking institutions – as part of their compliance with Shariah law — avoid high levels of leverage and risk, and avoid engaging in speculation. As a result, these institutions have a higher level of stability than many conventional financial firms. Continue reading

IDB President calls for creation of new financial system of mixed type

Azerbaijan holds intense operations to develop the financial services industry in recent years, and great success has been achieved in this direction, the Islamic Development Bank (IDB) president Ahmad Mohammad Ali said at the 5th Global Forum on Islamic finance of the IDB on the topic “Global stability on the way to integration” held in Baku.

“However, we see that the Islamic financial system has helped us to withstand the impact of the global financial crisis. Such kind of responsibility for the sustainable development of our industry and spread of Islamic financial system in the world stands before each of us,” Ahmad Mohammad Ali said.

Holding such a forum provides an excellent opportunity to spread the principles of the Islamic bank financing in the broadest scale, Ali believes. Continue reading

Singapore ready to
 promote Islamic finance

SINGAPORE – The outlook for Islamic finance remains positive despite the negative spillover from the financial crisis and it is set to play a bigger role in global finance, Singapore’s Trade and Industry Minister Lim Hng Kiang said.

“The industry is expected to continue growing at twice the pace of its conventional counterpart,” the minister said on Monday during his opening speech at the inaugural Asia summit of World Islamic Banking Conference (WIBC).

Singapore ready to
 promote Islamic finance

Kiang, who is also deputy chairman of the Monetary Authority of Singapore (MAS), said, “Surveys estimate that the industry will soon cross the $1 trillion mark in total assets.

“As a financial centre …. Singapore stands ready to play a wider developmental role in promoting Islamic finance in response to rising regional demand for Shariah-compliant products and services,” the minister said. Continue reading

Islamic finance – steady amid chaos


Reviewed by Robert E Looney

In 1936 in the depths of a world-wide economic depression, John Maynard Keynes described the decline of the world’s financial markets as a result of playing at a casino: “Short-term speculation with little regard to fundamentals.” A cursory examination of the current global financial crisis suggests little has changed since Keynes’ day – the conventional financial system, despite various patches and fixes over the years, is still prone to periods of extreme instability and abuse.

Unfortunately, the economics profession has provided little in the way of constructive input in re-designing a more stable financial architecture. Mainstream neo-classical equilibrium economic analysis has not systematically incorporated elements that would account for the conventional system’s instability, let alone provide a framework for predicting the occasional bouts of extreme instability.

Liberal-minded neo-Keynesians have done a bit better in identifying some important precursors of the crisis, in particular, the destabilizing role of huge private sector financial deficits in countries with large external deficits, such as the US. The Keynesian view certainly played a big part in the post-crisis response (fiscal stimulus) of many developed and emerging countries.

On the conservative side, monetarists certainly raised doubts about the Federal Reserve’s abnormally low interest rates and expansive monetary creation in the years preceding the crisis. Yet, at best, this line of analysis does not go very far beyond the warning of an impending bubble and likely bout of inflationary pressures.

No doubt a leading monetarist, Milton Friedman, if alive today, would reaffirm a firm belief in Say’s Law of the smooth functioning of unimpeded (free) markets. Those going down this road contend the current financial instability is wholly the fault of too much government. As Friedman often observed, “The Great Depression, like most other periods of severe unemployment, was produced by government mismanagement rather than by any inherent instability of the private economy”. Lax money and credit policy of US Federal Reserve under Alan Greenspan would be the focus of his ire today.

Monetarist offshoots such as the Rational Expectations School, while producing good explanations of the stagflation experience of the 1970s, have not been able to systematically incorporate irrational behavior into their models. The lemming or investor-herd mentalities observed in recent years remain well beyond their comprehension.

As Martin Wolf of the Financial Times has noted, of the Western interpretations of the global financial crisis, it appears those economists working in the Austrian tradition were more nearly right than anybody else. In particular, they have argued that: central bank inflation-targeting is inherently destabilizing; that fractional reserve banking creates unmanageable credit booms; and that the resulting pattern of investment, linked not to the marginal efficiency of capital but rather to financial returns, explains the subsequent financial crash.

The best non-Western explanation of the global financial crisis is presented in the book under review, The Stability of Islamic Finance: Creating a Resilient Financial Environment for a Secure Future by Hossein Askari, Zamir Iqbal, Noureddine Krichene and Abbas Mirakhor. However, this book is much more than just an alternative explanation of the current depressed state of the world economy – it is an elegant, sophisticated assessment of Islamic finance as a viable, realistic alternative to the current conventional system. Perhaps to the surprise of many, the author’s assessment finds a number of similarities between the core elements of Islamic finance and that of the Austrian School.

Certainly Islamic finance and banking institutions are thriving relative to conventional finance. The Banker’s 2009 survey of Islamic finance found the volume of sharia-compliant assets of the Top 500 grew by an extremely healthy 28.6%, rising to US$822 billion from $639 billion, in 2008 (forecasts are that this figure will top $1 trillion in 2010). At a time when asset growth in the Top 1,000 world banks slumped to 6.8% from 21.6% the previous year, Islamic institutions were able to maintain the 28% annual compound growth achieved in the past three years.

The industry also continued to expand, with 20 new entrants bringing the number of sharia-compliant institutions to 435, with a further 191 conventional banks having sharia windows. The Islamic banking geographies are stretching beyond the existing strongholds of Iran, Saudi Arabia, Bahrain, Malaysia and the UAE to Europe, South Africa, Kenya and Indonesia.

Advocates claim Islamic finance has been immune because sharia-compliant institutions are focused on the fundamentals, with simple products bearing robust mechanisms for risk mitigation. Market analysts have stressed the correlation between asset quality in Islamic institutions and their conservative approach to risk as an insulating factor. Many conventional bankers contend the success of Islamic finance in riding out the financial storm can be attributed to the fact it is underpinned by tangible assets such as real estate.

Askari et al incorporate all of these considerations into their demonstration of the advantages of the Islamic alternative, but they also go several steps further than most previous assessments. Prior examinations of Islamic finance have devoted most of their attention to its ethical side – prohibition of interest and the ban on lending for certain activities – gambling, alcohol production and so forth. As its title suggests, The Stability of Islamic Finance demonstrates, in addition to Islamic finance’s usual virtues, its relative stability with regard to the conventional system.

As the authors note (p 209), conventional banks fail to meet inherent stability conditions even in the presence of prudential regulations. First, credit losses from debt default to the depreciation of assets may create a large divergence in relation to the liabilities that remain fixed in nominal value. Second, bank credit has no fixed relation to real capital in the economy and bears no direct relation to the real rate of return. Unbaked credit expansion through the credit multiplier and further leveraging is a fundamental feature of conventional banks. Cash flow could fall short of expectations and force large income losses on banks, especially when the cost of funds is fixed through a predetermined interest rate.

Third, banks caught in a credit freeze, with a drying up of liquidity. may default on their payments. Fourth, banks are fully interconnected with each other through a complex debt structure; in particular, the assets of one bank instantaneously become liabilities of another, leading to fast credit multiplication. A credit crash causes a dramatic contagion and a domino effect that may impair even the soundest banks.

While their analysis is much too rich to detail here, suffice to say they demonstrate that an Islamic system overcomes many of these limitations. In particular, in an economy governed by the principles of Islamic finance, the rate of return on equities is determined by the marginal efficiency of capital and time preference, and is positive in a growing economy. This implies that Islamic banks are always profitable provided that real economic growth is positive. This establishes a basic difference between Islamic banking where profitability is fully secured by real economic growth and conventional banking where profitability is not driven primarily by the real sector.

A critical feature noted by the authors, and one consistent with the Austrian ideal for banking, is the fact that the Islamic system operates on a 100% reserve requirement. In this system, investment banking operates on a risk/profit sharing basis, with an overall rate of return that is positive and determined by the real economic growth rate.

Islamic banks do not create and destroy money; consequently, the money multiplier, defined by the savings rate in the economy, is much lower in the Islamic system than in the conventional system, providing a basis for strong financial stability, greater price stability and sustained economic growth.

In short, the requirements of Islamic finance – lower proportions of debt to equity, a condition that the lender share profits and losses with the borrower, and a focus on transactions based on tangible assets – mean that Islamic banks have not become entangled in the toxic-debt instruments that have laid waste to many of the conventional banking giants.

In sum, The Stability of Islamic Finance has many strengths. Perhaps the greatest one is the ability of the authors to bridge the gap between the conventional and increasingly sophisticated global financial system and that represented by Islamic finance. Previous attempts at contrasting the systems largely failed because authors were strong in one area but lacked the expertise to provide an in-depth critique of the other system. Professor Askari is an acknowledged world-class expert in both systems and combined with his three co-authors anchors an analytical team uniquely capable of integrating the workings of an Islamic system into the increasingly complex global context.

Still, there are many problems confronting a wider based adoption of Islamic financial systems. In addition to the usual West-Islamic differences over interest, ethical roles of business etc, a number of fundamental changes would have to take place in the way Western governments manage their economies. For one thing, the adoption of popular Keynesian stimuluses during recessions would be much more difficult than is currently the case. Central bank discretionary policy would have to be abandoned for strict rules on monetary expansion. Reserve requirements of 100% on banks would fundamentally alter the banking business – the list goes on.

Having shown its inherent advantages over the current system, hopefully the authors will collaborate on a follow-on book detailing how the Islamic financial system can transition outside of its current narrow confines to be a viable alternative to the conventional system.

The Stability of Islamic Finance: Creating a Resilient Financial Environment for a Secure Future by Hossein Askari, Zamir Iqbal, Noureddine Krichene and Abbas Mirakhor. John Wiley & Sons, Singapore (2010). ISBN: 978-0-470-82519-80. Price US$49.95, 256 pages.

Robert Looney is a professor of national security affairs, and associate chairman of instruction, Department of National Security Affairs, at the Naval Postgraduate School, California.

Dealing with the Financial Crisis: An Islamic Approach

In this paper I try to note the main causes of the current financial crisis that is leading the world into an economic disaster of unprecedented proportions.

This is followed by a discussion on how can we get out of this undesirable situation and move towards a better world. In between I shall also comment on why some of the conventional strategies of crisis management are proving to be ineffective. I conclude indicating the systemic changes that should accompany economic strategies in order to move towards an enduring solution.

What Happened

The story is by now well known. Debt financing grew to an extent the repayment capacity of the borrowers could no longer sustain. This was most visible in the housing sector in the United States of America. But it pervaded all sectors of the economy almost all the world over. With so much debt floating in the market, securitization and repackaging took the debts to the common man and those managing their savings. The easiest way to make money grow became, not productive enterprise, but manipulating other people’s debts.

Complex derivatives and risk absorbing products like Collateralized Debt Obligations (CDOs) and Credit Default Swaps (CDSs) attracted the financial institutions entrusted with investing people’s monies for profit. Monetary authorities also obliged financial markets with supply of cheap money. Higher and higher leverage became order of the day. When the inevitable bursting of the bubble occurred and defaults became endemic financial institutions failed to fulfill their obligations. Liquidity dried up. Things stopped moving. Globalization ensured that these effects reached everywhere.

Role of Debt

A modern economy is built around debts that bear interest. Monetary management as well as financial intermediation is effected through interest bearing debts. This makes the system crisis prone. It also makes the system unfair and inequitable. Let us take the monetary system first.

The amount of fiat money the monetary authority decides to float in the economy finds its way to people mostly through banks and other financial institutions. Whatever monies are given to people directly as salaries, wages and grants etc., also find their way to banks and other financial institutions as deposits and investments.

The monies that go out from banks and other financial institutions mostly do so as debts carrying interest. Some of these debts are repaid and that much new money is cancelled, but the interest paid remains as revenue for the bank. Some debts are renewed on maturity, often with accrued interest added to the principal. Bank loans are part of an economy’s money supply. To the extent the volume of interest bearing loans increases, the money supply also increases.

Parallel to this stream of debts runs another stream and in the same direction. It is bonds issued by the government; Central, State and Local; as well as bonds floated by private sector corporations. Government bonds’ supply has had a tendency to increase over time.

As time passes the volume of debts in the economy goes on increasing. Obligations to pay interest due and/or return the principal can be met from wealth newly created or already existing. In case debt financed productive enterprises fail to produce additional wealth large enough to meet obligations of repayment with interest, a dip unto old wealth already existing before the debt-financed projects were started becomes necessary. Wealth redistribution in favor of lenders is an inalienable feature of an economy in which debt financing predominates.

In money terms, there is not sufficient money to meet all payment obligations, in view of the interest added to the principal that came out as newly created money. The only way out is to renew some of the outstanding debt or monetize it (by exchanging newly printed currency for debt papers). The debt based system of creating new money and financing productive enterprises necessitates ever increasing volumes of debts. It is difficult to imagine how these debts can ever be paid. To lighten the burden of debt a severe bout of inflation will be necessary with all its unhealthy consequences.

When the economy is not growing fast enough defaults occur (as happened in the US recently). Insurers step in to capitalize on the fear of default by offering to buy risk of default from dealers in debt. Speculation in the market for buying and selling risk is detached from speculation in the market for real goods and services. It is not based on relevant information in the real sector, nor do actuarial tables exist to make any kind of scientific calculation possible. Speculating in the market for risks is a zero sum game relying on chance.

On the other hand the ability to sell risk of default to a third party makes the lending institutions reckless. They tend to make more loans to less creditworthy clients and fail to monitor their behavior for ensuring repayment. At the same time the distance between people whose monies are lent and those who are supposed to repay them goes on increasing. The long chain of anonymous intermediation separating lenders and borrowers coupled with transfer of risk to specialist institutions creates a make believe world in which nothing but profit margins and leverage matters.

Some of this attitude spills over to the stock markets too as dividends and share prices are manipulated with a view to attracting more savings. An increasing proportion of society’s real resources; men, machines and other material;  engages, not in producing real goods and services but in manipulating numbers and creating complex new financial products which enable more bets on already existing profit opportunities.

Two consequences inevitably follow. Firstly, it is impossible for all debt obligations to be met making default endemic at some stage. The impossibility is rooted in the twin phenomena of interest added on all debt to be repaid and in the uncertain nature of productive enterprise financed by debt. The system cannot survive without destroying some obligations to repay the outstanding debts. Secondly the distribution of income and wealth tends to become more unequal over time.

This consequence is rooted in the transfer of some of the existing wealth from the borrowers to the lenders as the legal system obliges even those debt –financed entrepreneurs who failed, to repay the sum borrowed with interests added. A second factor contributing to enhanced inequality is the banks keeping a lion’s share of the seigniorage resulting from money creation in a fractional reserve system.

The competitive mechanism needed to channelize a major part of seigniorage to common man; depositors, clients and other users of banking services; does not function. The reason competition fails to bring down real interest rates to levels in sync with proper sharing of the benefits of money creation, the seigniorage, with people is that interest rates are treated as a policy tool, determined administratively rather than by the market forces.

The central bank has to take into consideration the requirements of the country’s external balance of payments and the domestic needs for money supply, etc., in deciding upon the key rate at which it would lend money to commercial banks, which rate in turn forms the basis of   the other interest rates in the economy.

Treatment of Uncertainty

Risk and uncertainty are inalienable features of life. The society’s interest lies in mitigating and minimizing uncertainties. Two things greatly contribute towards minimizing uncertainties rooted in human behavior as distinguished from those rooted in nature, like earthquakes, floods, etc. One is behavioral norms or rules every economic agent adheres to.

For example telling the truth, keeping promises and honoring contracts contribute immensely towards efficiency. Second is cooperation in facing uncertainties that takes the form of sharing risks that cannot be eliminated. This feature contributes to efficiency as well as equity and fairness. In both cases the crucial factor is incentives, the answer to the question why would one do this rather than do that?

In the conventional system as exposed by the current crisis we have failed on both counts. Lies have been told, norms have been breached, rules violated and contracts ignored. Most economic agents tended to shift risks to others (who in many cases would gamble with them) rather than share risks equitably. Looking at the incentives there is little else than the desire to get rich quickly with little regard for any societal considerations.

Contradicting the claims that somehow the culture of unabashed greed will also ensure the survival of the weak and the uninformed, the world has landed into a morass of unprecedented difficulties. The conventional system lacks proper incentives for economic agents adhering to rules and/or cooperating to minimize risks (through information dissemination, for example) and sharing risks equitably.

What Is To Be Done?

I suggest that a comprehensive solution requires attention towards all the three factors highlighted above: role of interest based debt, speculative and exploitative approach towards risk and an incentive structure focused on maximization of private gain. But before arguing in favor of this approach it is necessary briefly to look at the other efforts currently being made to check the disaster.

Current efforts at amelioration can broadly be summed up under three categories: Pouring more liquidity into the system; more strict regulation of the financial markets; and nationalizing parts of the financial system that cannot be fixed in the two above ways. There is no intention anywhere of changing the role of interest bearing debt, adopting a radically different stance towards risk management or restructuring incentives by influencing peoples’ motivation.

I submit that as a result of the above measures currently being taken to fix the situation the economy will someday regain its feet on the ground but it will be laden with new problems and will certainly carry the seeds of a new crisis to appear sooner or later. Meanwhile the distribution of income and wealth may become more unequal and the level of confidence in the suitability of the system may fall further.

At the international level the rehabilitation of world’s developed economies will not mean an end to endemic poverty in Africa and South Asia, nor shall it bring promise of enduring peace as the current ways of solving the crisis fail to touch the fundamental causes of hegemonic policies of the rich towards the poor.

Enduring Solutions

Humanity needs a change of heart. The philosophy of greed and individualism must give way to a cooperative approach to living. This necessitates disabusing minds from the unfounded premises of neoclassical economics that extolled individualism and maximization of private gain as the surest way to societal felicity.

It also requires bringing ethics and morality back into economics and finance. That is the only way the loss of people’s trust into the banks and other financial institutions can be reversed. People trust each other when they perceive they are pursuing mutually reconcilable goals. The current loss of confidence is born of the opposite perception, each fearing the other is out to exploit and take advantage of him.

Ethics and morality are not luxury goods a society can dispense with. The very fabric of social living is built around them. An exchange economy, especially its financial system is very sensitive to loosening of that fabric. Reinforcing that fabric brings customers closer to their managers. When the reverse happens people stop trusting their managers and withdraw into their cocoons, to great disadvantage of society.

An enduring solution to the current crisis calls for restoration of trust between people by replacing the tendency to treat others as mere instruments for promoting the interests of the self with a relationship rooted in universal human brotherhood. It is only such a revitalized society that can throw up an administration that can protect public interest from being pulverized by vested interests. Writing tougher rules and tighter regulations cannot remedy a situation in which many of the regulators happen to be former or potential future employees of vested interests.

Absence of ethics and morality from the public square is also responsible for the dangerous situation at the international level. Almost all international financial institutions; the IMF and the World Bank included; have lost the trust of poor countries. Most international organizations are perceived as tools for serving hegemonic designs of the rich and powerful nations.

Reform Agenda

An alternative to debt financing from which interest is absent is the first step towards change. Parallel to this we need a way of creating money in which interest plays no role. Equity can easily replace debt as the basis for issuing new money by the monetary authority and/or by other financial institutions. There are viable schemes of monetary management without involving interest but this is not the place to go into details. As regards finance various sharing schemes offer ways of equity financing that suit different sectors of the economy. Leasing and cost plus financing also offer viable alternatives in some sectors.

Once the menace of interest is banished from the economy keeping speculation within reasonable limits would become easier. Society should insist on transparency wherever other people’s money is involved. It should also arrange for dissemination of information that would help minimize uncertainty. It will be easier to eliminate gambling on the stock market and/or betting on un-measurable risks in such an environment. Given respect for other people’s interests within and outside the country, hegemonic policies may gradually be replaced by international covenants based on mutuality.

Last but not the least is the newly gained awareness of ecological imbalances caused by man’s pursuit of unlimited growth. Conventional system has no inbuilt mechanism to limit growth to sustainable levels, based as it is on individualism and pursuit of private gain. A new approach requires not only new regulations but a move away from individualism and pursuit of private gain towards socially conscious decision making and cooperation in realization of common interests. Man must learn to live in moderation in view of the limits our environment imposes. Moderation in pursuit of material gains and in consumption has been part of the teachings of religions in general and Islam in particular. It is time to bring them in.

Mohammad Nejatullah Siddiqui is a leading Indian Islamic scholar, whose specialisation is Islamic Economics. Recipient of the King Faisal Award for Islamic Studies, he has taught at the Aligarh Muslim University and the King Abdul Aziz University, Jeddah.

He was a Fellow at the University of California, Los Angeles and Visting Scholar at the Islamic Development Bank, Jeddah. He served for sixteen years as member of the central committee of the Jamaat-e Islami Hind. He is the author of numerous books.